Right or wrong, the Bulls Are Running on Wall Street
By Pierre Belec
Reuters
NEW YORK (July 21) - It's happening all over again. The bulls are running on Wall Street, just weeks after the stock market suffered a stunning fall.
Dumb or smart? What the experts are saying might change your mind.
''People are again buying stocks that caused them trouble a few months ago,'' said Bill Valentine, president of Valentine Ventures LLC.
''Ultimately, it's just blind hope and faith that things would return to normal. When the market sold off in April, it was telling us something -- reconcile stock prices with reality,'' he said.
Indeed, the bulls are back in town after stocks ran into a brick wall in the spring with the Nasdaq composite index plummeting 35 percent.
The technology-heavy Nasdaq has vaulted more than 30 percent from its May 23 low. The Standard & Poor's 500 index is flirting with its March 24 record close of 1,527.46 and the Dow Jones industrial average is up nearly 9 percent from its March 7 low.
While life is different on the Street this year after the market went through a bone-jarring drop in the spring, the only thing that hasn't changed is the stock market's high valuation.
The economy has lost some of its gusto after the inflation-fearing Federal Reserve pumped up interest rates six times since June 1999.
One of the best clues that the economy and stocks may be heading into dangerous waters this summer is that the Fed is cutting the growth of the money supply, which is one of the most powerful forces in the U.S. economy, analysts say.
The Fed has flipped into a ''no cash for nobody'' mode from one of ''too much cash for everybody.''
''The market's valuation should be acknowledging these things,'' Valentine said. ''The slowdown in the Fed's money growth; higher interest rates than a year ago, which makes future earnings less than they are today and finally, economic growth has fallen because of the Fed's intent to slow things down.''
Strangely enough, the new generation of investors has no idea what makes this money supply thing so critical.
Here's the persuasive lowdown. Both the economy and stock market need a consistent diet of money in order to grow. Historically, there has never been a period of economic prosperity that did not coincide with large money growth.
Simply put the money supply, which is controlled by Fed Chairman Alan Greenspan and the other pinstriped bankers, can be likened to people's paychecks. As long their income keeps increasing, the more stuff they can buy. But the trouble will come when they keep shelling out cash while their paychecks are shrinking.
Still not convinced about the importance of the money supply?
When the Fed cut the money supply's growth below the critical level of 7.5 percent in April, the speculative-driven Nasdaq market dropped by a stunning 35 percent.
The opposite happened in late 1999. Faced with a potential financial market disruption from the Y2K computer bug, the Fed let loose with the biggest money supply increase in the nation's history, adding some $200 billion to the system, or a huge 15 percent hike on an annualized basis.
The central bank wanted to make enough cash available to prevent a run on the nation's banks as people feared the Y2K bug, which threatened to bite on Jan. 1, 2000, would cripple computers around the world.
But the flood of money to counter what turned out to be just minor computer headaches, was more than the economy could absorb and it found its way to Wall Street, triggering an explosion that sent the stock market to record highs in the final weeks of 1999.
The buckets of cash also made a lot investors brave about buying stocks on credit, lifting margin debt to a record of nearly $280 billion by the end of the first quarter of 2000.
Now, the Fed is cutting back on the money supply while at the same time, it has raised interest rates a half dozen times since last summer.
''Historically, whenever the money supply spikes up by more than 10 percent as it did last year and the growth later drops back to less than 7.5 percent, it leads to a stock market correction, which at times has been very severe,'' said Don
Hays, president of The Hays Market Focus Advisory Group, investment consultants.
Most experts track the M3, which is the Fed's broad definition of money -- currency, bank deposits, travelers' checks and money market mutual funds.
''I think it's almost a sure thing that money supply growth will drop under the 6 percent level, eventually falling close to zero before the Fed's new discipline takes hold,'' Hays said.
The Wall Street veteran said history counsels caution. Investors would be wise to keep track of the weekly money numbers, which are issued late on Thursdays. While the data can be volatile, the best way to track the changes is to take a four-week average of the results, then annualize the growth rate over the last 13 weeks and 26 weeks and year over year, he said.
Hays predicts that the second leg of the spring's bear market will coincide with a drop in the money supply growth to less than 6 percent.
''When the growth rate drops to that level, I expect all kinds of different dominoes to start dropping,'' he said. ''Loan loss reserves will continue to mount, the bankruptcy rate will increase, consumer sentiment will start to drop and heretofore perpetual bullish analysts and strategists will start to be 'concerned' for the first time in four years.''
Paul Kasriel, chief U.S. economist for Northern Trust Co., in Chicago says the Street is not giving the money supply the respect it deserves.
''There are very few things upon which economists agree. Most, however, pay lip service to the notion that inflation is a monetary phenomenon -- that is inflation is the result of too much money chasing too few goods,'' he said.
''Yet, when it comes to analyzing the behavior of recent years' inflation, hardly a word about money growth is mentioned -- by the Fed or most economists.''
Kasriel said the money supply growth does a great job of giving Wall Street a heads up on emerging changes in inflation.
The money supply has been less popular under Greenspan's administration. But a decade or more ago, fluctuations in the data were the talk of the town and they fueled speculation about the direction of the Fed's monetary policy as much as today's pronouncements by the Fed chairman.
What's happened is that Greenspan has since programmed the Street to look at things such as the Consumer Price Index and the Employment Cost Index. The Fed chief is said to view the price of scrap steel as a good gauge of inflation and economic activity.
The stock market has gotten a boost from hopes that the Fed is through raising interest rates.
''Investors are cheering the possibility that the Fed will stop raising interest rates but the element that is missing in today's market is that we are not back to where we were a year ago. The truth is that interest rates have been raised six times since June 1999,'' Valentine said.
The jump in rates has made the companies' future earnings worth less than 12 to 18 months ago, he said.
Do investors have a simplistic mentality?
''Yes. People think that if the Fed is raising rates, then that's bad for the market and if it is no longer raising, then that's good for the market,'' Valentine said. ''So they're all piling back into stocks because now the coast is clear. Well, it's not that simple. We are in a different position than we were.''
Valentine's bet: The market will go through another nasty selloff before bottoming out by October.
''The Fed fund futures price, which is a great predictor of interest rates, still has priced in one or two additional increases by the Fed between now and December,'' he said.
''But the overly optimistic stock market is pricing in no more moves by the Fed. The Fed fund futures market has an 85 percent correct predictability about the central bank's next moves,'' he said.
As they say in Las Vegas: Place your bets!
For the week, the Dow Jones industrial average was off 79.19 points at
10,733.56. The Nasdaq composite index lost 152.28 points at 4,093.86 and the Standard & Poor's 500 index was down 29.89 points at 1,480.09. |
